ECB’s Monetary Policy Spillovers to Financial Markets: Evidence from Small Open Economies

This study explores the effects of ECB’s monetary policy surprise spillovers on the financial markets of Sweden and Denmark, two small open economies (SOEs) with close ties to the euro area. Analyzing high-frequency intra-day interest rate data from 2006 to 2022, the research highlights several key findings. Path surprises correlate with increase in government bond yields, particularly in Denmark, and lead to euro depreciating against the Swedish krona, suggesting a portfolio rebalancing mechanism. In contrast, target surprises have no significant impact on short-term money market rates, implying stronger control by domestic central banks over shorter yields. During periods when interest rates are at the effective lower bound (ELB), ECB surprises negatively affect equity markets in Sweden and Denmark, especially in the industrial sector. This work suggests that while SOEs can manage short-term interest rates, their long-term yields are more influenced by larger central banks. Additionally, it introduces a new indicator for assessing the impact of monetary policy surprises, beneficial for financial economists.